India’s Central Bank Rate Hike Not a Mere Policy Normalization

March 19, 2010

The Reserve Bank of India’s first rate increase since July 2008 was motivated by accelerating price increases for non-food manufactured goods, rising costs for fuel and other commodities, higher-than-expected overall inflation, and the risk that all this will boost expected inflation against the backdrop of a broadening domestic demand-led economic recovery.  Wholesale prices for nonfood manufactured goods accelerated from an on-year rate of minus 0.4% in November to plus 4.3% in February, while fuel costs intensified suddenly from minus 0.8% in November to +10.2% just three months later.  A statement released by the RBI candidly admits that inflation has picked up by more than had been anticipated and warns that authorities “will take further action as warranted.”

Back in late January, the central bank served notice that rising interest rates were likely coming soon by announcing a two-stage 75-bp increase of cash reserve requirements from 5.0% to 5.75%.  Today’s measures were increases of just 25 bps in the key repo rate to 5.0% and the reverse repo rate to 3.5%.  However, the urgency attached to monetary policy tightening was underscored by the fact that the next scheduled policy meeting had not been until April 20.  No doubt, rates will be lifted another 25 bps or perhaps more then.  From a repo peak of 9.0% for three months, rates were slashed during the Great Recession by 100 bps in October 2008, 50 bps in November, 100 bps in December, another 100 bps in January 2009, 50 bps in March and 25 bps in April 2009.

India becomes the economy with the largest GDP to raise interest rates thus far.  Other countries where there have been increases are Australia, Norway, Israel and Malaysia.  With India dropping one shoe today, China will be moving very soon.  The paths of advanced and developing economies are diverging further.  This is a different world from the one left in the twentieth century.

Copyright Larry Greenberg 2010.  All rights reserved.  No secondary distribution without express permission.



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